Category Archives: Auditing

How to Audit IAS11-IAS16?

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Audit question [june2011 Q2] IAS11:

 

Construction Contract(attachment1)

In the last week, two significant issues have arisen at Bill Co. The first issue concerns a major contract involving the development of an old riverside warehouse into a conference centre in Bridgetown. An architect working on the development has discovered that the property will need significant additional structural improvements, the extra cost of which is estimated to be $350,000. The contract was originally forecast to make a profit of $200,000. The development is currently about one third complete, and will take a further 15 months to finish, including this additional construction work. The customer has been told that the completion of the contract will be delayed by around two months. However, the contract price is fixed, and so the additional costs must be covered by Bill Co.

Forecast profit before tax is $2·5 million.
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Thanks for taking on the role of audit manager for the forthcoming audit of Bill Co.

(i) I have just received some information on two significant issues that have arisen over the last week, from Sam Compton, the company’s finance director. This information is provided in attachment 1. I am asking you to prepare briefing notes, for my use, in which you explain the matters that should be considered in relation to the treatment of these two issues in the financial statements, and also explain the risks of material misstatement relating to them. I also want you to recommend the planned audit procedures that should be performed in order to address those risks.

(8 marks)

Answer to [june2011 Q2] IAS11

Matters to be considered

Materiality:

The loss on the contract of $150,000 represents 6% of the forecast profit before tax and is therefore material to the statement of profit or loss.

Accounting treatment:

  1. The $150,000 loss needs to be recognized immediately to the statement of profit and loss and other comprehensive income.
  2. The delay completion of contract would result in penalties and this should be accounted for under IAS37 provision, contingent liabilities and contingent asset.

Risks of material misstatement:

  1. There is a risk that loss of $150,000 has not been recognized in the statement of profit or loss and hence overstate the profit figure by $150,000.
  2. There is also a risk that a failure to provide for a provision or disclose contingent liability in the note of the FS and this would result in understatement of liability and expense or under disclosure.

Audit procedures:

  1. Inspect the customer-signed contract to verify the fixed price and any penalty clauses relating to late completion.
  2. Recalculate the budget for the Bridgetown development to verify the accuracy of the schedule and confirm the expected loss of $150,000.
  3. Inspect report made by the architect regarding the structural improvements to verify the estimate of the additional costs.
  4. Discuss the additional costs with contractors to assess if the estimate appears reasonable.
  5. Review Bill Co’s cash flow forecast to ensure adequate funds to cover the additional costs.

 

Audit question: [Q11:DEC2008 Q1] IAS 12

 

(b) Describe the principal audit procedures to be carried out in respect of the following:

(ii) The recoverability of the deferred tax asset. (4 marks)

Answer to [Q11:DEC2008 Q1] Income taxes IAS 12

(ii) Principal audit procedures – recoverability of deferred tax asset

  1. Agree figures in the current and deferred tax calculation to tax correspondence.
  2. Inspect profitability forecast to agree there is enough forecast taxable profit to offset against the loss.
  3. Perform analytical procedure by evaluating assumptions used in the forecast to ensure it’s in line with auditors’ business understanding.
  4. Perform analytical procedure by assessing time taken to generate profit to recover tax losses and if it takes many years to generate such profit and the recognition of deferred tax asset would be restricted.
  5. Inspect tax correspondence to verify there’s no restriction for company to carry forward and use losses against future taxable profits.

Cash Audit

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Cash Cycle

Bank and cash audit

Bank:

Things to check:

  • Cash account
  • Bank confirmation
  • Bank statement
  • Bank reconciliation

Cash audit objectives

Cash balances include cash on hand and at bank. Cash on hand includes undeposited receipts and petty cash. Cash at bank includes cash held in current and savings accounts which is available on demand. Unlike any other account balance, cash may be either an asset or a liability. The latter arises where the bank with which the entity holds an account allows the entity to write cheques in excess of the balance in the account up to an agreed limit known as an overdraft.

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Assertion  
Existence Recorded cash balances exist at the balance sheet date.
Completeness Recorded cash balances include the effects of all cash transactions that have occurred.
Rights and obligations The entity has legal title to all cash balances shown at the balance sheet date.
Valuation Recorded cash balances are realisable at the amounts stated on the balance sheet.
Presentation and disclosure Cash balances are properly identified and classified in the balance sheet.
  Lines of credit, loan guarantees and other restrictions on cash balances are appropriately disclosed.

 

 

Bank confirmation letter:

Content:

  • Balances in the accounts
  • Maturity and interest terms on loans and overdraft
  • Guarantees
  • Loans

 

Approaches:

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Way1: listing balances & information:

 

Account 1: balance is $50             yes     no

Account2: balance is $100             yes     no

 

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Way2: requesting details of balances:

Q1: what is the balance in the bank account1?____________________

 

Q2: what is the overdraft facility? _______________________________

 

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Request procedures: (arts) (Auditors to bank and bank to auditors)

  • Auditors should get written authority from client and provide it to the bank;
  • Auditor’s request must refer to client’s authority letter;
  • The request should reach the branch manager at least one month before client’s year end.(Time)
  • Auditors should specifically check that the bank response content and returned directly to auditors.

Bank reconciliation

Idea: difference between cash account and bank statement.

 

Reason:

 

 

  1. unrecorded differences: appear in bank statement but not in cash book.
  2. timing difference: appear in the cash book but not in bank statement.
  3. outstanding lodgment: we receive the cheque but we haven’t clear it in the bank(cash in transit)
    unpresented cheques: we’ve written off the cheque but supplier not clear it in the bank

  4. Errors.

 

 

Q: Recon

     
Date Narrative $

 

    Date Narrative $
1 Otc Balance b/f 3,285     10 May Cheque #2025 1,000
3 Otc

4 Otc

Cheque #2124

Cheque #2127

 

250

1,476

 

    11 Otc Cheque #2126 500

 

          17 Otc Cheque 1441 250
          20 Otc Cheque 1442 350

 

     

5,011

    30 Otc Balance c/f 2,911

5,011

1 NOV                      2,911

 

 

Hangseng Bank
To: Jim                  account number: 264-561652118         26 Otc 2014
Date Details Paid out Paid in Balance
2014   $ $ $
1 Otc

4 Otc

Opening balance

Receipt

 

 

 

1,976

3,285C

5,261C

17 Otc 1441 250   5,011C
20 Otc 1442 350   4,661C
24 Otc

 

Bank charges 35   4,626C

 

  D=Debit C=Credit    

 

Note:

Company incorrectly recorded check #2127 for $1,476 instead of $1,976

There is unrecorded bank service charge of $35.

 

Required:

(a) Prepare bank reconciliation statement for the company.
(b) Describe substantive procedures an auditor would perform in verifying a company’s bank balance.(10marks)

Answer:

Cash balance:                     $2,911

+ Error($1,976-$1,476)                $500

-bank service charge                 ($35)

$3,376

Bank statement balance             $4,626

+outstanding logment

#2124                       250

-unpresented checks

#2025                         ($1,000)

#2126                          ($500)

$3,376

 

Bank reconciliation is not perfect because:

  • Misstatements can’t be discovered when there is a failure to bill a customer;
  • Misstatements can’t be discovered when there is an embezzlement of cash receipts from customers by staff.

Procedures on bank reconciliation:

General procedures:

  • Agree all balances listed on the bank confirmation letter to Co’s bank reconciliations to ensure completeness of bank balances.
  • Agree all balances listed on the bank confirmation letter to Co’s trial balance to ensure completeness of bank balances.
  • Agree bank balances in Co’s trial balance to balances listed on the bank confirmation letter to ensure existence of bank balances.
  • Inspect company’s bank reconciliation and check the additions to ensure its accuracy.
  • Reperform the bank reconciliation to ensure its accuracy.

 

Cash book:

  • Trace bank charges/standing order to supporting documentation to ensure its existence (there are no fictitious reconciling items).

Bank statement:

  • Agree all of the outstanding lodgements to the pre year-end cash book, post year-end bank statement to verify the cut off is correct.
  • Agree all unpresented cheques to a pre year-end cash book and post year-end statement to verify the cut off is correct (for any unusual amounts or significant delays obtain explanations from management).
  • Inspect any old unpresented cheques to verify if they need to be written back into the purchase ledger(DR I/S CR payable rather than Cr cash) as they are no longer valid to be presented.
  • Perform analytical procedure by reviewing the cash book and bank statements for any unusual items or large transfers around the year end to verify any window dressing issues.

 
Cash audit:

Petty cash book using imprest system

Receipt Date Narrative Cash Postage
100 12.11.2014 Cash receipt    
  13.11.2014 Stamps 10  
    Total 10  

 

Float amount=100
Spend 10
So restore 10: DR petty cash 10  CR bank 10

  • Count cash balances at the year end and agree to the petty cash book.
  • Inspect the unbanked cheques(undeposited receipts) and make sure they have been paid in to the company’s bank account and agree this to bank reconciliation.